A Deep Dive Into General Electric's Growth Strategy

A look at the inner workings of General Electric.

Jan 21, 2014 at 6:30PM
Ge

Source: Flickr/Jeffrey Turner.

In recent years, the stock market has taken note of a revival at the industrial company General Electric (NYSE:GE). GE's shares have more than doubled since early 2009, buoyed by a growing industrial backlog and investors' appetite for its 3% dividend yield.

Still, some investors remain skeptical due to GE's not-so-distant banking fiasco, and because it's an atypical grab bag of diverse businesses. Since it would be foolish (with a lower-case "f") to hop on board without first kicking the tires, let's look at what's been driving growth since GE hit rock bottom in 2009.

What's under the hood?
For years, analysts and investors alike have criticized conglomerates such as GE for being less than the "sum of their parts." GE and its ilk became famous for an MBA management style that often overreached and resulted in "diworsification" instead of healthy "diversification."

As a result, GE spent the past decade streamlining a vast portfolio of businesses down to nearly a handful. Today, when investors buy shares of this conglomerate, they're really investing into six different industries: energy, aviation, health care, transportation, appliances and lighting, and banking.

Like the old days, GE still strives to be the best in every industry, but its strategy has evolved. The businesses operate with greater autonomy, according to the top brass. Furthermore, GE tends to subdivide large businesses into smaller entities if they grow too unwieldy. GE's energy group serves as a case in point, as the $50 billion segment was recently split into power and water, oil and gas, and energy management.

Some overlap still exists, to be sure, but the managers, economic drivers, and business models differ on the whole. As The Wall Street Journal noted a few years back, the new "GE way" is to "go deep, not wide."

A look at GE's average revenue and profit growth over the past four years reveals some disparity across the six key operations. For the sake of simplification, I consolidated the energy businesses and removed any adjustments for corporate overhead or discontinued operations. The average growth rate of revenue and earnings over a five-year span is reflected in the following chart:

Due to changes in GE's reporting, the data only exists in a workable fashion for the last half-decade. This, in turn, means that GE Capital -- shown as "banking" -- bounced back from a very low earnings baseline of $1.3 billion in 2009. For perspective, GE Capital's earnings fell 84% from $8 billion in 2008.

As a result, average earnings growth in banking towers over the rest of the businesses, even as revenue has taken a step back. GE's banking business engages in commercial, consumer, real estate, and energy lending, but the company has de-emphasized banking while attempting to strengthen its balance sheet in recent years. As I pointed out yesterday, this has been a successful transition that has bolstered the bottom line while stabilizing a once-risky operation.

Of the remaining businesses, only transportation appears to be an outlier, averaging 13% revenue growth and 39% earnings growth over this time frame. Generally speaking, demand for GE's locomotive engines has grown alongside a railroad industry that's recovered dramatically since the depths of the recession.

The road ahead
Although transportation is a "core" business, it's a relatively small slice of GE's pie, contributing 4% of total revenue and 5% of total earnings. The additional core businesses that really matter for GE's future growth are energy, health care, and aviation.

As reflected in the chart below, these three combined units accounted for 61% of total revenue and 60% of total earnings at GE in 2013, excluding any corporate overhead or discontinued operations. (Toggle between earnings and revenue using the gray radio buttons near the top.)

As shown, banking still carries some heft, but investors can expect it to play a diminishing role. GE intends in the near future to spin off its North American consumer-oriented loan business, which accounted for 35% of GE Capital revenue and 52% of GE Capital earnings in 2013.

In the meantime, GE aims to focus on its industrial segments to increase organic revenue and ultimately achieve double-digit-earnings growth during 2014, if all goes according to plan.

Foolish takeaway
GE's ability to achieve sustainable industrial growth will determine whether its stock will flourish or flounder. So far, the industrial units are humming along, although they appear overshadowed by a rejuvenated banking operation. In the future, that will hopefully subside.

Investors with a solid grasp of these moving parts will be able to recognize how the transition is unfolding and whether shares look attractive. GE's price-to-earnings ratio of 19 compares to a current industry average of 21. Investors looking for an industrial company with plenty of momentum might want to hop on for the ride.

Find the next General Electric
General Electric is a prime example of a stock that made investors rich if they held for decade after decade. Letting your winners run is a strategy that we take seriously, in the spirit of great investors like Warren Buffett. That's why our CEO, legendary investor Tom Gardner, is so adamant about finding the greatest businesses for his ultra-long-term portfolio. He recently isolated his best ideas, and permitted us to reveal "The Motley Fool's 3 Stocks to Own Forever." These picks are free today, so click here now to uncover the three companies we love.

 

Isaac Pino, CPA owns shares of General Electric Company. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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